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Weekly Market Movers Part 1: A strategy guide to prior week’s market movers and their lessons for the coming week for traders/investors of all major asset classes via both traditional instruments and binary options.

PRIOR WEEK

We begin with the broad technical picture, and then look at what’s behind it.

TECHNICAL PICTURE

We wrote in last week’s market review:

Note in the weekly chart (below) that the[S&P 500] index has also breached its 200 week EMA (pink). Unless the index can rally back above this level around 1200 soon, then we’re looking at a decisive break below this level. As the below long term weekly chart of the index shows, breaks below this level usually bring longer term pullbacks.

ScreenHunter 13 Aug 14 04 211 WEEKLY MARKET MOVERS 1: PIIGS BOND EXPOSURE UNDERMINING BANKS, MARKETS

S&P 500 WEEKLY CHART JANUARY 2001- AUGUST 2011 COURTESY ANYOPTION.COM 13aug 14 0421

Key Points

The last two times the index dips below its 200 week EMA (pink line) we got a longer term downtrend lasting many weeks.

Short version: charts are looking more bearish.

Here’s the updated weekly chart below, which shows the most recent candle of the past week making a deeper, more decisive penetration below the 200 week moving average. This move was mostly due to the Thursday selloff, added by the lesser selloff Friday.

ScreenHunter 07 Aug 20 22 25 WEEKLY MARKET MOVERS 1: PIIGS BOND EXPOSURE UNDERMINING BANKS, MARKETS

WEEKLY S&P 500 COURTESY ANYOPTION.COM 07aug 20 2225

Looking at the daily chart, we get additional insight into the technical damage sustained this past week.

ScreenHunter 04 Aug 20 21 45 WEEKLY MARKET MOVERS 1: PIIGS BOND EXPOSURE UNDERMINING BANKS, MARKETS

S&P 500 DAILY CHART COURTESY ANYOPTION.COM 04AUG 20 2145

Building Bearish Momentum

Deepening “death cross”: As 50 day EMA (red) falls further below the 200 day EMA (pink). This raises the odds of more downside, as we discussed in detail in S&P 500 FLASHING DEATH CROSS: THE BEAR IS BACK.

Increasingly bearish layering of EMAs: The stronger the downside momentum, the more we see the shorter term (and thus most sensitive to changes in momentum) moving averages crossing below the longer term ones, the stronger the downside momentum. Note shortest duration 10 day EMA (blue) under the longer duration 20 day EMA (yellow), which in turn is below the longer duration 50 (red), 200 (pink) and 100 (purple). The layering is now almost perfect, except that the 100 day EMA has yet to fall beneath the 200 day EMA, but that’s usually the last step given that these two are slowest to respond given their inclusion of so many older data points.

The index is now deeper into the Double Bollinger Band Sell Zone (the zone bounded by the lower dark green and orange bands): Once price enters this area it means downward momentum is strong and suggests higher odds of more downside to follow. For more on this see: 4 RULES FOR USING THE MOST USEFUL TECHNICAL INDICATOR, DOUBLE BOLLINGER BANDS

In addition, we have a developing bearish flag chart pattern on the daily S&P 500 Chart below.

ScreenHunter 05 Aug 20 21 58 WEEKLY MARKET MOVERS 1: PIIGS BOND EXPOSURE UNDERMINING BANKS, MARKETS

S&P 500 DAILY CHART COURTESY ANYOPTION.COM 05aug 202158

FUNDAMENTAL MARKET MOVERS

So what was behind these moves on the S&P 500, our primary barometer of risk appetite?

The short version:

  • Growing anxiety over the stability of EU banks, particularly those of the core nations most heavily exposed to GIIPS bonds. The ECB bond buying program helped, but EU policymakers made things worse.
  • Ongoing evidence of slowing global growth

Here’s a day by day breakdown of how these and other forces played out, and the lessons we learn.

Monday

Risk assets rose on a combination of:

  • Upward momentum from the prior week’s close.

  • Data: Better than expected Japanese GDP and US retail sales.
  • M&A Activity: Google’s (NASDAQ:GOOG) purchase of Motorola Mobility (NYSE:MMI).
  • Possible optimism that the latest Merkel-Sarkozy emergency meeting might actually produce meaningful results.

Tuesday

The risk asset rally ends due to:

  • Technical Resistance: From a technical perspective risk assets were hitting near term resistance levels and thus needed new reasons to move higher. For example, the S&P 500 was now back around the key 1200 level. However, they got the very opposite kind of news.
  • German preliminary GDP was below expectations 0.1% vs. 0.5% forecasted), feeding ongoing fears that even if its credit is still solid, Europe’s leading exporter and bailout funder can’t grow if its end markets aren’t buying.
  • The Merkel-Sarkozy meeting was a disappointment, offering no dramatic solutions like Eurobonds or major new funding for troubled states or banks that might have calmed markets. Nothing new was said, except that Sarkozy proposed a new banking tax, which didn’t help banking stocks, which were already battered on concerns about solvency due to exposure to GIIPS bonds. Markets had been about even at that point, but started selling off thereafter.
  • There were further reports from German politicians that Eurobonds were a non-starter in Germany and could only be considered as a last-resort. However over the course of the EU crisis, today’s last resort becomes tomorrows solution (bailouts, ECB buying of junk-rated sovereign bonds, etc)
  • Italian shares were further hit by news of a new “Robin Hood tax”.
  • US data was mixed at best. Ominously, US bank shares were selling off hard once again.

Wednesday

Markets overall were flat, but there was one important news item that would contribute to Thursday’s route.

The ECB’s latest tender operation for emergency 7 day liquidity – a kind of dollar-denominated discount window for Europe, showed one bank borrowing $500M. This was noteworthy because this facility had not been used since March 2011 and no one had borrowed in size since March 2010. Apparently, some major EU bank was feeling pressured, no surprise after the prior week’s reports that both Asian and US banks were cutting off European banks from overnight lending except for on a case-by-case basis. This lack of confidence in EU banks arose from fears that their exposure to GIIPS bonds and high leverage were making them too risky. We suspect this news was at least part of the reason for the strong plunge at the opening of Thursday trading in Asian markets.

Thursday

The Panic Returns On Renewed Fears About EU Banks, US Slowdown, Dim Prospects For A QE 2-Type Rescue For Markets

  • Asian stock indexes closed mostly 1%-1.5% lower, Europe and the US were down between 4%-5% (?!), ending any thoughts that last week’s wild swings were an aberration. Top market movers included.
  • Renewed concerns over European Banking.
  • First, there was the prior day’s report noted above that suggested at least one big bank was having trouble finding short term borrowing sources and needed to resort to a rarely used ECB facility.
  • Feeding concern about European banks was a WSJ story that now the US bank regulators, fearing that Europe’s banking crisis could spread to the US, were scrutinizing the US branches of Europe’s biggest banks to assess their stability and access to funding. The article stated that the NY Fed was very concerned about European banks facing funding difficulties in the US.
  • Second Annual Greek Bailout Looking Less Certain: Also out were reports that both Finland, then Holland, would not make further loans to Greece without collateral to guarantee the loans. The obvious risk is that Greece cannot offer that to all lending nations, so if too many demand it the rescue plan will collapse.
  • More Bad US Data Furthers Fears Of US Double-Dip Recession.
  • Worse Inflation & Economic Data Lower QE 3 Prospects: CPI initial jobless claims, and existing home sales all printed worse than forecast. This combination of more inflation and lower growth will make it harder for Bernanke to justify more QE, which is what saved markets last summer after they plunged on EU worries. With markets again rattled as Europe deteriorates, many are hoping for more QE. However that becomes less likely with both inflationary pressures and any real evidence that the last stimulus package really helped. Bernanke may well be unable to help markets at this time.
  • Philly Fed Flops: Then at 10am EST (3pm GMT) the Philly Fed manufacturing report came out, and it was a disaster, printing at -30.7 vs. +3.2% forecasted, one of the worst showings in a decade. Markets spent the rest of the day plunging.

Lessons For The Coming Week: More Of The Same

Europe Sovereign Debt & Banking Crisis Anxiety Keeping Markets At Risk Of Deeper Plunges

Europe remains the big threat, and it’s getting worse still.

The fact that the end of week selloff did not even test last week’s lows provides some basis for believing we’ve seen the worst for now. The ECB bond buying program is working for now. After announcing that it bought €22 bln of Spanish and Italian bonds during the week of August 8th, yields on these have remained below 5 % this week, out of the 6-7% “red zone” that signals credit markets have become too expensive and a rescue package is needed.

However the politicians continue to waste whatever time the ECB is buying them. As I and many others have been writing for some time, the EU has to choose between radically greater fiscal integration and continued full national sovereignty. They can’t have both. Those who can assist the weaker states won’t do so without adequate controls over those nations’ budgets and all that goes with these (taxation enforcement, social benefits, etc), and the debtor nations show no sign of being ready for this. Nor are the funding nations ready to guarantee the debts of the debtors, as we saw by Germany’s continued rejection of Eurobonds that would obligate all member nations.

In fairness to the politicians, their hesitancy is not unjustified. From a practical perspective, voter support is not present for further sacrifices for the sake of preserving the EU, be it further austerity in debtor nations or funding from creditor nations.

From a theoretical standpoint, the EU doesn’t work as a currency union, however noble the original intentions were. As Mauldin and Tepper write their book Endgame, arguably one of the very best books out about the global debt mess, an optimal currency union is characterized by:

  • Mobility of labor & capital
  • Flexibility of wages and prices
  • Similar business cycles
  • Fiscal transfers to cushion the blows of recession to any region

Europe has almost none of these. Very bluntly, that means it is not a good currency area.

The best summation of what’s probably got to happen soon was from The Telegraph’s Ambrose Evans-Pritchard article early last week. He said that EU leaders have to chose between one of four hard choices.

  1. Tear Up The Political Map Of Europe: Fiscal union and an effective end to the sovereignty of the individual nation states.
  2. Tear Up The ECB Mandate: Order a multi-trillion Euro “unsterilized” (i.e. money printing) bond purchases to fund the GIIPS until they start growing again, at the risk of destabilizing Germany.
  3. Continue Their “Muddle Through” Policy: Measures that are too little too late, likely to end in an EU-wide banking collapse and dissolution of the EU.
  4. Admit Defeat And Start Unwinding The EU: This was not mentioned but is implied.

Pritchard argues #2 is the most likely because it offers the path of least resistance, and indeed appears to have already begun with Italian and Spanish bond purchases. See the article for details.

The key point: With CDS rising in Germany and France, it’s now clear that Europe’s core itself is a credit risk if it must truly bear the cost of bailing out the GIIPS. That means the endgame in the EU approaches, not even in a matter of months, but weeks, if not days.

Slowing Global Growth

Both Morgan Stanley and Goldman Sachs downgraded their forecasts for global growth in 2011 and 2012. The large cap firms that comprise the Dow Jones Industrial Average and the S&P 500 are getting an increasing portion of both revenues and growth from outside the US. The prospect of a growth slowdown in China and India is far more should be more worrisome to investors than a slowdown in the US or Europe.

Don’t Expect Salvation From Jackson Hole

Markets await this coming Friday’s speech by Fed Chair Bernanke at the annual Fed symposium at Jackson Hole, Wyoming. Last year, he used this occasion to announce that the Fed was considering a second round of asset purchases that ultimately became QE 2. Just after the August 26th speech markets began a rally (300 point on the S&P 500) that lasted until this past May. Naturally, there are those hoping for more of the same. We don’t think anything like another round of asset purchases is coming because

  • Today the US faces a greater inflation threat.
  • The past year showed that additional liquidity infusions did not restart genuine growth (though it was helpful for pumping up asset prices) while it added another $600 billion in debt.
  • After the past month’s debt ceiling fight, the idea of Congress accepting additional spending seems, ahem, unlikely.

Ramifications: What To Do As Investors & Traders?

In essence, continue what we’ve been recommending.

Global growth is slowing. We’re facing new US budget fights towards the end of September. Things are likely to get scarier in the EU in the coming weeks. That suggests a few things.

Equities

The above technical and fundamental analyses suggest more downside in the coming weeks barring a major new money printing operation by the ECB, the Fed, or both, though more likely the ECB. That makes us reluctant to go short or long equities. So we wait, though the above S&P 500 charts say go short and sell into rallies.

Commodities

If in fact the ECB bond buying program is going to mean new Euro printing, a falling EUR, and probably yet more gold buying, despite the already parabolic rise in gold over the past weeks, as the US debt ceiling fight and EU crisis have continued to send markets seeking hedges from the two most widely held fiat currencies.

Commodities tied to growth, like oil or copper, remain in firm multi-week downtrends so these remain short term shorts. However, regardless of growth rates for the coming years, oil remains a longer term buy given that supply is peaking at current price levels and emerging market demand continues to grow.

Currencies

Shorting either the EUR or USD is treacherous, given that both continue to look almost equally ugly. The EU mess will continue to favor currencies of nations with strong balance sheets like the CAD, CHF, AUD, NOK, SEK, etc, regardless of near term fluctuations.

Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.

Source: Weekly Market Movers 1: PIIGS Bond Exposure Undermines Banks, Markets